EXPOSED: The Sleazy Tactics Brokerage Firms Are Using To Make Silicon Valley Employees Rich

Facebook employees are selling stock after they quit –
and getting rich.Jim
Migdal

Employees at hot Silicon Valley companies are once again getting
rich selling stock.

This time, they're doing it even without their companies –
Facebook, Groupon, Twitter and others – going public.

They are selling their stock on private secondary markets like
SecondMarket and SharesPost – two new exchange/brokerage firms
that have created a thriving market for hot private stocks.

The rise of the private markets is controversial. In addition to
creating excitement about a new source of private-market
liquidity, these markets have spawned concerns about
"asymmetrical" information and insider trading as well-informed
insiders dump their stock on clueless outsiders.

If you do not own stock in Twitter already it is a must. If you
already own Twitter you need to add to your position. There
are two absolute must have positions – Facebook and
Twitter! This is the first Twitter stock we or anyone else
has had in the past six months and like Facebook it will continue
to trade up in price rapidly!"

You can imagine why emails like this one worry people. In it,
Felix Investments called the stocks of Twitter and Facebook
"absolute must have positions" because... well, because Twitter
and Facebook stocks were going up! Felix provides no details
about the financial performance of Twitter and Facebook in this
solicitation email – because it didn't have any. The financial
performance have not been publicly released.

In other words, even in the private markets, the stock-promotion
game is already alive and well.

THE BACKGROUND

It used to be that employees at hot Silicon Valley companies
could wait for the IPO and then just sell their stock on the
pubic markets, where anybody with an E*Trade account could by
their stake.

These days, since IPOs are so much rarer, former employees have
to find "accredited investors" that the SEC will allow to buy stakes in private
companies. The SEC has this rule because private companies,
unlike public companies, don't have to disclose their financials,
and this can make them riskier investments. Accredited investors
are individuals whose earned at least $200,000 the last two
years, and expect similar income next year, too. They can be a
married couple who combine to earn more than $300,000. The idea
is that they understand and can afford the risk.

Because it would be difficult for some former employee of a hot
Silicon Valley startup to find an "accredited" investor all on
their own – and because private companies like Facebook and
Twitter would like to remain under the SEC's 500 shareholder
limit for private companies – these employees are selling their
stock to middlemen operating huge funds, of which "accredited"
investors can own a stake.

This puts the onus on the the middlemen operating those funds to
find investors willing to invest in fast-growing, speculative
Silicon Valley companies that do not tell anybody how much money
they have, are making, or plan to make in the future.

Perhaps the very most successful of these middlemen is a firm
called Felix Investments – the firm that wrote the email you read
before.

Felix Investments is run by a Wall Street veteran named Frank
Mazzola, who works out of a shiny, glass skyscraper way downtown.
Mazzola is bald, tanned, and a big smiler. On the phone, he
sounds like a less cartoonish version of Vin Diesel in
Boiler Room.

He won't tell you this – the SEC forbids him too – but Mazzola
runs at least two large and growing funds with large stakes in
Facebook and Twitter.

He's purchased stock from employees and investors in companies
like Facebook, Twitter, and Groupon at least 70 times. Sixteen
pre-IPO Google employees are investors in his
funds. Prior to running Felix Investments as its CEO,
Mazzola was a managing director at Advanced Equities. That stint
didn't go as well as he'd hoped, Mazzola told us on the phone.

Even as it aggressively makes former employees of hot startups
rich, Felix Investments has, thanks to that email and others like
it, developed a poor reputation in some quarters of Silicon
Valley.

Importantly, Conway's view of Felix Investments is not unbiased.
Through his Twitter fund, RC Chirp, he's actually one of Felix's
competitors.

But Conway isn't alone in his views, either. Several other
sources complained to us about Felix Investments.

One source alleges that when Felix sells its own investors on
Twitter and Facebook stock, it will, in the absence of real
financials from the companies, produce revenue figures "in thin
air."

Mazzola calls this accusation "totally inaccurate." He says Felix
Investments will sometimes repeat to its clients what media
outlets are reporting about the companies in which they are
invested. "CNBC has numbers on Facebook all the time," he
says.

Besides, he adds: "Any numbers that [the media] published a year
ago have been proven out, and maybe even look to be on the
conservative."

Several other sources alleged that, in violation of SEC rules,
Felix Investments will solicit non-accredited investors with
which it has no previous relationship and sell them very hard on
private company stock using, in one source's words, "used car
salesman techniques."

Remember that email with all the exclamation marks, describing
Twitter and Facebook as " two absolute must have positions"? It's
not the only example.

On its Web site, Felix Investments has the following text next to
Facebook, Twitter, and LinkedIn logos:

"We offer our investors the opportunity to invest in companies
that don't want money, don't need money, and won't take money.
This is when you want to invest!"

We don't know if the email we started our story with was sent to
an accredited or non-accredited investor.

Either way, it may violate SEC rule 15.c.2.11, which stipulates
that a broker is not allowed to solicit interest in a company's
stock from investors unless the broker has access to that
company's balance sheet. Felix Investments does not have access
to Twitter's balance sheet.

When we read this email to Michigan law professor Adam Pritchard
– one of the top securities law professors in the country and
author of the authoritative text book, "Securities
Regulation: The Essentials," – Pritchard said, "That
email sounds like a solicitation of interest to me. I don't think
it's a judgement call. "

Mazzola says he did not personally write that email, but he
doesn't deny it came from Felix Investments.

Either way, the email doesn't bother him, he says, noting that
Twitter has gone from a $2 billion valuation to a $10 billion
valuation since that email went out. "In that particular case the
excitement was justified," he says.

"Maybe from time to time individuals get very excited. You have
to believe in the products you're getting behind. If you don't
that would be a bigger issue," he argues.

Others don't share this view.

A source briefed on the compliance practices at SecondMarket, a
Website that helps connect buyers and sellers of private company
stock buyers and sellers, tells us that the language on Felix's
Web site and in the email produced above is the sort that
resulted in SecondMarket banning Felix from its platform.

Mazolla says he's never been informed of any such ban, and that
it's him that's not doing business with them.

"I'm quite confident that if there was anything on their site
that we wanted to buy, I would be able to do so. We don't have to
use middlemen. We hired a senior guy from SecondMarket last
year."

Pritchard says its likely that SecondMarket is being pro-active
because "they don't want to give the SEC ammunition to say that
this market needs to be regulated."

Pritchard says the SEC could respond to Felix Investment's
behavior – if indeed it does amount to any violations – with a
cease and desist or an injunctive action.

***

One question you might have about Felix Investment's reputation
and it's alleged solicitation of interest is: So what?

Who cares if Felix Investments is sending out screamingly bullish
emails about Facebook and Twitter?

So far, you might say, Silicon Valley employees and investors are
getting rich and the "YOU MUST OWN TWITTER" email has been proven
right. You might even pull up the incredible chart we've
pasted below, which shows the prices at which "accredited"
investors bought LinkedIn stock before it's IPO, and the price at
which they were able to sell after:

So…so what?

Try this: Felix Investments admits to telling its clients –
and, allegedly, people who are not yet its clients – to buy stock
in companies which they know very little about. While everything
on the private market keeps going up, that may seem something
less that crazy.

But there is no "new normal" and eventually, one of these
companies is going to do much worse than anybody on the outside
could have expected.

And that's when proverbial "mom and pop" investors who bought in
on screaming emails and then lost everything will come back with
their lawyers. And they'll go after anybody who had any part in
the whole mess.

Correction: An earlier version of this post said
Alex Payne sold his stock to Felix Investments. Payne did not,
though he says Felix has approached him several times.